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At the Cato Institute’s 34th Annual Monetary Conference (Panel 2)

Thursday, November 17, 2016 11:39
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Photo Credit: Jeff Upson

Photo Credit: Jeff Upson



Moderator: Josh Zumbrun – National Economics Correspondent, Wall Street Journal

Athanasios Orphanides – Professor of the Practice of Global Economics and Management, MIT Sloan School of Management

H. Robert Heller – Former Member, Federal Reserve Board of Governors

Daniel L. Thornton – Former Vice President and Economic Advisor, Federal Reserve Bank of St. Louis

Zumbrun introduces the panel, saying they are monetary policy practitioners.

Athanasios Orphanides begins by praising Friedman, mentioning the book Monetary Mischief. (Note: Amazon Commission)

Limited space for fiscal policy given high debt levels.  Monetary and fiscal are always linked, though central bankers are loath to discuss it.  Puts up a graph of rising government debt 1998-present.  Also graphs Italy, Germany, Japan.  Is there a debt trap now?  Is there monetary mischief, inflation, now?

(DM: Phil Gramm just sat down next to me.)

Can debt be sustainable over the long run? WIll there be policies that kill growth?  Inflation is too low?  Are there policies that raise the cost of financing debt? (Financial Repression)

Japan was already experiencing deflation prior to the crisis.  ECB gets its own crisis as a result of their structure.

Puts up a graph of policy of ECB, BOJ, and Fed.  Suggests that quantitative easing was warranted, and other abnormal monetary policies.  Suggests that BOJ QE was mild until 2013.

Puts up a graph of Central Bank balance sheet sizes.  Then one of average interest rates for government debt.  Then one of real per capita GDP, suggests that Japan has not done much worse than the US, though demographics are a problem.

Comments that QE is a help to governments in financing their debts.  Look at gross debt net of central bank holdings.

ECB great for strong economies, and poor for weak economies.

Fed — should we be concerned about the balance sheet?  IMFsays we can grow out of the huge balance sheet if the balance sheet does not grow.

Unsound fiscal policy overburdens central banks.

Heller: everything I want to say has been said already.  Monetary mischief: Monetary policy does not serve the nation.  Debt trap: the det grows faster than GDP inexorably.

Suggests that a 0-2% target would be better than 2% for inflation.  2% consensus under Greenspan — but that is not price stability — eventually Bernanke defines 2% as price stability.

QE was ineffective, and the Fed always overestimated its value.  Limited room for future stimulus. Perverse effect on savings.  Must save more to get the same amount of future funds.  Growing income and wealth inequality.

Hyman Minsky: “Every expansion creates the seeds of its own destruction.”

Pension funds suffer and are underfunded.  Life Insurers suffer a little.  Stock market tracks QE.  The rich do well as a result.

Moving closer to a Federal Debt trap.  (Guy next to me says “Kaboom” when looking at the debt graph.)  Interest payments double as interest rates normalize.  (DM: that’s why they won’t normalize — at least not willingly.)

Thornton: The Fed’s policies are a disaster, and they are ongoing.  QE and forward guidance on long-term yields.  Risk-taking is reduced, and GDP grows more slowly.  No empirical support for QE.  Keynesian economics have led to a credit trap.

Puts up a graph of CD rates versus t-bills.  Then Baa yields minus Aaa yields — markets had stabilized by 2010 by these measures.  Bernanke also argued that QE reduced term premiums, but markets are not segmented.

That said, FOMC’s low interest rate policy, helped make long rates low.  As the ’90s progressed, Fed funds became uncorrelated with long Treasuries.  Detrended, after May 1988, behavior changed because the FOMC used the Fed funds rate as the main policy tool, which affects short rates predominantly.

Graph with high negative correlation between the Fed funds rate and the spread between 10 and 5-year Treasury yields.  Quite striking.  (DM: this is all bond math)

Graph of household net debt as as fraction of disposable income.  New bubble of stocks plus real estate.

Argues that credit trap has been going on for 50 years or more.   Reliance on credit is evident from the growth  in government debt, which is a function of Keynesianism.


Q1 Chris Ingles, CPA: Isn’t the Fed enabling the growth of a socialist state?  Isn’t growth coming from government deficits?

Orphanides says blame governments, not central banks.  CBs get forced into enabling the politicians in order to keep things stable.

Q2: Mike Mork, Mork CApital Management — wouldn’t it be better to let interest rates float to aid the market’s allocation of capital?

Thornton: Fed can’t really control interest rates.  We could get out of the zero lower bond at any point by selling bonds and adjusting policy.  Take away the excess reserves and the market will find its own level.

Orphanides: can use balance sheet or rates — focus on the results of price stability

Heller: Money supply prior to mid-80s under Volcker gave way to Fed funds under Greenspan.  Existence of money market funds was a reason for that.

Patricia Sands from George Mason U:  Were the central banks really surprised?  Why do Central Banks exist in the first place?

Orphanides: we want to avoid inflation via monetizing the debt.  We sometimes get second and third best solutions.  We want to avoid the worst cases.

Heller: CBs can’t bail out governments without risking hyperinflation.

Thornton: interest rates are not the solution.  They don’t create big changes in spending.  (DM: Yes!)


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